REIMAGINING THE KOREAN WEALTH MANAGEMENT MARKETexperience of wealth management services. Wealth...
Transcript of REIMAGINING THE KOREAN WEALTH MANAGEMENT MARKETexperience of wealth management services. Wealth...
Joong Ho Park, Partner, Head of KoreaBaro Han, Principal Jonas Heckmann, Engagement Manager Jungjun Park, Consultant
REIMAGINING THE KOREAN WEALTH MANAGEMENT MARKET
© Oliver Wyman 1
Reimagining the korean wealth management market
WHAT WENT WRONG? ROOT CAUSES AND REMEDIESPrivate investments and financial institutions play vital roles in the Korean economy. The investments are a key pillar of households’ retirement provisions, while the institutions give people access to financial instruments that earn a return on their savings and help them plan for retirement.
But repeated cases of mis-selling over the past decade or so have shaken the confidence of both consumers and regulators in their financial institutions, in particular banks and securities firms. In the most recent scandal, the six major Korean banks sold a combined total of 822 billion won ($710 million) worth of high-risk derivative-linked securities (DLS) and derivative-linked funds (DLF) to about 4,000 investors.1 In some cases these products were sold without full disclosure of their embedded risk. In others, they were sold to clients with inappropriate risk profiles or to clients whose risk profiles had been manipulated to make them appropriate for riskier investments. The Korean Financial Supervisory Service (FSS) has determined that banks and securities firms failed to properly assess (a) the riskiness of these products; and (b) the suitability of these products for investors, given their sophistication and risk appetite.
1 Initial investigation result announcement from Financial Supervisory Service (“FSS”) on August 19st, 20192 AnnualtrendsoffinancialmisconductsannouncedfromFinancialSupervisoryService(“FSS”)
The scandal was just the latest in a series of mis-selling incidents that have hit Korean investors over the past 10+ years. These have spanned a variety of industry players, including banks, securities firms, and asset managers. They involved products such as DLSs and DLFs, real estate, and exchange-traded notes. Between 2010 and 2018, individual investors lost 2.2 trillion won ($1.9 billion) due to financial misconduct including mis-selling, according to the FSS.2
The number of incidents shows that, despite selected efforts, Korean wealth managers
have not yet comprehensively addressed the root causes of mis-selling. Korea is a large and mature investment market – the 10th largest globally and the 4th in Asia, measured by total investable financial wealth. But the country’s banks lag behind their peers in other developed economies in sales and risk management practices.
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Exhibit 1. Selected examples of mis-selling scandals in Korea after the global financial crisisTimeline of selected mis-selling scandals in Korea
Equity FundsA bank failed to provide sufficient investment information,
especially the possibility of losing the initial investment. The fund lost more than 90% of its value due to the global
financial crisis in 2008
KOSPI 200 Option A securities firm sold an options product that had previously
recorded a large loss
Equity-linked securitiesFinancial institutions sold high-risk ELSs to client whose
risk profile was not suitable for the product
Dongyang Group Corporate BondThe group marketed commercial paper and bonds
from low-rated subsidiaries, while pretending that they had robust businesses
DLSs/DLFs linked to foreign interest ratesBanks mis-sold high-risk DLSs/DLFs by misguiding investors to regard it as safe investment, leading to huge losses for investors
Lime Asset ManagementKorea’s biggest hedge fund, Lime Asset Management, suspended redemptions after fraudulent investment schemes
Exchange-Traded NotesA bank mis-sold ETNs, violating the suitability principle and its duty of explanation. The bank classified the ETN product as medium-risk, though it was supposed to be classified as high-risk
German Real Estate derivative-linked fundsBanks are alleged to have mis-sold a real estate-related DLF product without sufficient explanation of the loss risk
KIKO (Knock-in, Knock-out)Banks failed to fully notify buyers of the risks of derivate products that were supposed to protect them against fluctuations in the US dollar-Korean won exchange rate. SMEs, the main buyers, suffered huge losses
Securities TrustsBanks sold trust products containing investments in KT ENS, a company that bankrupt after a loan fraud
Crude Oil derivative-linked securitiesDLS products were sold without explanation of the loss risk in case of an oil price drop
FINANCIAL CRISIS
2019
2015
2016
2017
2013
2014
Source: Oliver Wyman analysis
© Oliver Wyman 3
Reimagining the korean wealth management market
We urge industry players to take action to remedy the problem, including the following:
1. Be client-centricMany wealth managers still focus on selling investment products rather than providing customized solutions to address their clients’ investment objectives. In private banking, for example, Korean clients believe that their relationship manager’s understanding of their wealth needs is limited, according to Oliver Wyman’s 2018 Korean Private Banking Study. Clients also think that, in most cases, product recommendations are based on the wealth manager’s internal strategy and sales targets. To regain customers’ confidence, we think that banks and securities companies should fully understand their clients’ personal and investment objectives, as well as their level of sophistication and risk appetite. They should then provide solutions aligned to these objectives. Wealth managers must also appreciate that client needs are not static but need to be reevaluated on a regular basis, taking events into account.
3 Interim investigation result announcement from Financial Supervisory Service (“FSS”) on October 1st, 2019
2. Fully understand product and portfolio riskMany financial services companies including banks distribute products while relying on risk ratings provided by the designers of those products. These ratings are often static and simplistic. Distributing companies should improve their practices in three ways: (a) fully understand all the risks connected with the investment products – going beyond market and credit risks; (b) take a portfolio-based approach, in which they assess the risk-return profile of a client’s portfolio rather than just that of individual products; and (c) assess product and portfolio risk on an ongoing basis.
3. Invest in the right capabilities and behaviorThe FSS criticized banks’ excessive push for profits and lack of internal controls for appropriately managing risks.3 Banks and securities companies should invest in systems, processes, and staff that enable them to focus on their clients and manage risks. Each bank also needs to take a critical look at its corporate culture and assess whether or not it supports and incentivizes the right conduct and behavior.
Banks and securities firms should invest in tools, processes, and culture that enable them to focus on their clients and manage risks.
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A HOLISTIC APPROACH FOR TRANSFORMATIONAL CHANGETo rebuild client trust and prevent further misconduct, banks and securities firms should take a holistic approach that will bring about transformational change. This entails three pillars, the implementation of which will reduce future misconduct: better understanding clients, better assessing products/portfolio, and promoting change in the corporate culture.
In order to mitigate conduct risk, the action must go beyond a compliance exercise. But, if this approach is properly executed, the results will significantly improve client experience of wealth management services. Wealth managers will then be able to win back the trust of their clients, which will translate into increased market share – that is, growth in both the client base and in assets under management per client.
Know Your Client: Dynamic Assessment of ClientsThe first step in the holistic approach is to develop a 360-degree view of the client. This includes a clear understanding of the following:
Exhibit 2. Components of the holistic approach to transform Korea’s financial sales practices
Winning client trust back + Strong foundation for sustainable growth
Know Your Product: Dynamic assessment of product and portfolio
Know Your Client: Holistic understanding
of client
Embed New Conduct and Culture: Establish the right corporate culture and conduct
underpinning entire customer journey
Source: Oliver Wyman analysis
– The client’s risk profile – that is, their capacity and appetite for risk. Risk capacity means the financial ability to endure potential financial loss without significant harm to their standard of living. Risk appetite is more subjective.
– The client’s sophistication and experience in relation to investment products. This means whether the client has the knowledge and experience needed to fully understand the benefits and risks associated with complex investment products.
– The client’s investment objective. Examples could be to preserve wealth, to earn a moderate level of income, or to seek significant capital growth over the long term.
Leading global players have designed and introduced sophisticated tools to assess clients’ risk profiles. An example is given in Exhibit 3, which shows part of a detailed investment profile questionnaire, or IPQ.
Evaluating a client’s risk profile is not a mere compliance formality; it is a core part of understanding a client. The assessment should be reviewed periodically to reflect the client’s current characteristics and needs.
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Reimagining the korean wealth management market
Know Your Product: Dynamic Assessment of ProductsThe dynamic assessment of products especially concerns product risk. The regulator requires that banks and securities companies have a coherent, transparent view of the risks connected with products and portfolios, and they must come to this view based on their own, independent risk analysis. They should go through a comprehensive due diligence process to identify a product’s inherent risk, including the following considerations:
Exhibit 3. Investment profile questionnaire
Client Information Portfolio Structure Portfolio Quality Risk Analyzer Investment Proposal
OVERVIEW INVESTMENT PROFILE QUESTIONNAIRE
Section 1: Assessment of Client’s Risk Profile
Risk Tolerance
I have fully answered the questions, which are aimed at a holistic assessment of my risk and investment profile. I answered on my own initiative with the relevant and necessary information.
Most investments can fluctuate both up and down. How much could your investment fall in value over a 12-month period before you began to feel concerned and anxious?
Q1.
More than 25% Up to 5%Up to 25%
Q2. Investment A has a potential return of 30% and potential loss of 40% in any year. Investment B has an average return of 3% and the potential to lose up to 5% in any year. If you had 100 million won to invest, which of the following asset mixes would you choose?
80% in A, 20% in B
50% in A, 50% in B
20% in A, 80% in B
Mr. Lee currently has net investment assets of 550 million won. He has limited risk appetite and is uncomfortable with significant short-term loss of principal. His strategy is to pursue steady cash flow from fixed-income and high-income equity investments.
Client profile
OCCUPATIONSenior Executive
NAMELee Jin-soo
AGE55
LOCATIONSeoul
I have fully explained to the client the investment product and its risks and general characteristics, to ensure that it is a suitable investment.
Risk/investment profile
INVESTMENT KNOWLEDGE/EXPERIENCESophisticated investor (Score: 45/60)INVESTMENT NEEDSSteady income
OVERALL RISK RATING1 5
2.5
RELATIONSHIP MANAGER Kim Ki-hun
CLIENT Lee Jin-soo
Risk budget (Risk capacity/tolerence)
LOW
Limited
HIGH
Source: Oliver Wyman analysis
– Distributors should have their own independent product-risk rating framework and not just depend on risk classifications provided by the product issuers.
– Product-risk assessment should be comprehensive: Product-risk ratings should not just cover market and liquidity risk but also effectively address other risks, such as counterparty risk, concertation risk, legal risk, investment manager risk, and operational risk.
– Risk ratings should take worst-case scenarios: A risk rating should encompass not only familiar circumstances but also stress scenarios. Derivative-linked securities
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that tracked 10-year German government bonds are a good example. One such DLS sold in Korea included a barrier of minus 0.25 percent: If the bond’s yield went below this level, holders of these DLSs would lose the principal they had invested. Still, clients were led to regard these DLSs as a low-risk investment, since the 10-year German government bond’s yield had never been below this level, and it seemed highly unlikely that it would fall this low. In June 2019, however, the yield did fall below minus 0.25 percent, and many DLS holders lost the money they had invested in the securities. Clearly, this DLS should have been assigned a higher risk rating than it was.
– Product risk ratings should be dynamic, not static. Product risk should be reviewed periodically, and factors having an impact on an asset – such as macroeconomic or idiosyncratic events – need to be addressed in a timely manner. Here again, the DLS that tracked the 10-year German government bond yield is a good example. The yield had declined over in the preceding years and even went below zero in 2016. So, the risk of the yield hitting the barrier of minus 0.25 had actually been rising, and the risk rating should have been adjusted upwards.
– Portfolio-level risk is what matters. Measuring the risk of individual investment products is not enough. It is also necessary to constantly monitor and periodically review the risk level of a client’s portfolio, which is a function of the risk levels of the products it contains and of combining them. Wealth managers, as well as clients, should carry out such assessments, and they should go beyond the parts of the portfolio invested through themselves and also take into account other forms of wealth such as client’s real-estate holdings.
Banks and securities firms should incorporate the risk ratings of a client’s products and portfolio into their advisory process, by seeing whether they fit the client’s risk profile.
Exhibit 4 shows how important it is to provide investment advisory service to clients based on the understanding of client’s risk profile and portfolio risk management. Bank X offered the same high-risk DLS product to client A and B, and both clients have invested 100 million won in the DLS product. Client A (Mr. Hong) has invested a large portion (50%) of his assets in DLS despite his conservative risk profile and limited knowledge and experience of investment. Client B (Ms. Kim), however, is a sophisticated investor with high risk tolerance, and she has invested 6% of her assets in DLS along with other products, diversifying her portfolio. When an extreme market risk emerged, client A suffered a severe loss to his investments when the DLS product lost its value, whereas client B’s loss was relatively mild (at a portfolio level). If bank X ‘s investment advisory was based on the understanding of client’s risk profile, occupation, and portion of DLS product in the portfolio, client A could have avoided substantial loss.
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Reimagining the korean wealth management market
Exhibit 4. Comparison of two fictional clients who invested in high-risk products but face different consequences
NameHong Gil-dong
Age71
OccupationRetiree
NameKim Ji-Young
Age50
OccupationSenior manager at a multinational company
CLIENT A
INVESTMENT PROFILE
PROFILE PROFILE
Net Investment Asset 200 million won
Investment Strategy Short-term investing with fixed income
Risk Appetite Limited (Low-to-mid risk and return)
Investment Knowledge And ExperienceLow (never invested in derivatives before)
Net Investment Asset 1.6 billion won
Investment Strategy Value growth over time
Risk Appetite Enhanced (Mid-to-high risk and return)
Investment Knowledge And ExperienceHigh (has previously invested in derivatives and alternative funds)
Structure: Low(never invested in derivatives before)
Structure: Low(never invested in derivatives before)
PORTFOLIO
INVESTMENT PROFILE
PORTFOLIO
CLIENT B
Wealth managers failed to recommend right product for client’s investment needs and risk appetite
They also did not provide sufficient instructions and warnings on the risk of investment
His portfolio suffered huge loss, as is not diversified enough to mitigate market risk
Return(cumulative performance since inception)
Return(cumulative performance since inception)
120
Jul’19Jan’19Jul’17Jan’17 Jul’18Jan’1860
80
100
German 10Y Treasury Yield decreased
120
Jul’19Jan’19Jul’17Jan’17 Jul’18Jan’1860
80
100
German 10Y Treasury Yield decreased
Wealth managers recommended her investment products that suits with her investment/risk profile
She was fully informed about the risk of investment product
The portfolio was diversified enough to mitigate market risk, only causing moderate level of loss
50%100 million won in liquid assets – e.g.
Money market funds and deposits and etc.
50%100 million won in fixed income – DLS linked to yield of 10Y German government bonds
25%400 million won
in liquid assets – e.g. Money market
funds and etc.
19%300 million won
in equity – e.g. US growth funds
50%800 million won in fixed income – e.g. Emerging markets bond fund etc.
6%100 million won in fixed income – DLS linked to yield of 10Y German government bond
Source: Oliver Wyman analysis
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Global financial institutions are investing in building capabilities for product and portfolio risk calculation, investment suitability check for a client, and proactive investment portfolio management – for example through monitoring, alerts, and loss simulation via digital tools. Exhibit 5 shows an example of a tool to manage a client’s investment portfolio.
With digital tools, wealth managers will be able to provide systematic investment advice. They can empower front-line employees with a dashboard that monitors each client’s portfolio and its level of risk in real time. Clients will also be able to easily check the quality of their investment portfolios and access analysis of their portfolios and future investment opportunities.
Exhibit 5. Sample screen of a portfolio health-check tool
Client Information Portfolio Structure Portfolio Quality Risk Analyzer Investment Proposal
Net Assets as of 2019.12.31KRW 550,256,300
Investment Details
Net Performance as of 2019.12.31Year-to-date, 3.83%
Portfolio
NAMELee Jin-soo
AGE55
INVESTMENT STRATEGYOriented towards steady cash flowCURRENCYKorean Won (KRW)
Investment Structure Details
Bonds Liquidity Equities
Last update: a month ago
2 Potential Issues 2 Discussed Issues 4 No Issues
Credit Ratings
Maturities and Redemptions
Issuer Concentration
Sell rated securities
Bonds below Investment grade
Product Risk Classification (PRC)
Portfolio Risk
Asset Allocation Risk +
+
+
+
+
+
+
+
Status: Improved
There are 2 breaches that are not addressed yet
See Details
Quality
OVERVIEW
57.4%
23.6%
19.0%
Previous Score: 3/5PORTFOLIO HEALTH SCORE
3.5
1 5
Source: Oliver Wyman analysis
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Reimagining the korean wealth management market
Embed New Conduct and Culture: Establishing the Right Corporate Culture and ConductIt is essential for wealth managers to understand clients’ risk appetite, sophistication, and investment objectives and to be capable of assessing risks comprehensively and dynamically. These critical hygiene factors need to be supported by the right people with the right skillsets who have received the right training. Control processes will never be 100-percent failsafe; only a cultural uplift will deliver sustainable change.
Together with the Group of 304 – an independent global body comprised of senior representatives of academia and both the public and private sectors – Oliver Wyman in 2018 published a comprehensive report on the state of banking culture. The report, “Banking Culture and Conduct – a permanent
4 G30 is an independent global body comprised of very senior representatives of the public and private sectors and academia. It aimstodeepenunderstandingofinternationaleconomicandfinancialissues,andtoexploretheinternationalrepercussionsofdecisions taken in the public and private sectors. (see group30.org)
5 https://group30.org/images/uploads/publications/aaG30_Culture2018.pdf
mindset shift5,” proposed next steps, which were summarized in 12 recommendations for uplifting banks’ culture and the conduct of their staff (See exhibit 6).
Recommendation 4, in particular, is directly relevant to the mis-selling incidents that surfaced in Korea. Wealth managers should remove the link between quantitative sales targets – especially short-term targets – and compensation for sales staff. They should instead use measures linked to their clients’ success over the long term.
A truly client-centric service can only be achieved if the objectives of clients and relationship managers are aligned. Examples of measures for client success could be the risk-adjusted return on their portfolio or the growth rate of client’s assets under management.
Case study
Control processes will never be 100-percent failsafe; only a cultural uplift will deliver sustainable change.
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Exhibit 6. Twelve recommendations from G30 and Oliver Wyman on how banks can uplift their culture and conduct
12 areas where G30 and Oliver Wyman believe additional efforts and
attention are still required:
12Conduct risk oversight roles and responsibilities should be clear across the various
second line functions such as Human Resources (HR), Risk
and Compliance
11Banks should persevere in their
efforts to shift primary ownership of conduct risk to the
first line of defense to ensure conduct risk is truly owned by the business and is effective
10Banks should focus on hiring
people who align with the bank’s purpose and values as they strive to create the right culture for their organization, recognizing that recruiting is a critical element to creating the
right culture
9Banks should establish
credibility and enforcement through their disciplinary mechanisms for conduct
breaches to ensure employees take these measures seriously
4Banks should remove the link
between quantitative sales targets and compensation for
sales staff to minimize pressure that lead to misconduct and help
staff prioritize meeting customer/client needs
3Banks should consider the potential impact of
outsized incentives in their compensation mechanisms
2Bank boards and senior
management should work more closely with various
business units, and geographic and functional heads to
strengthen the quality and availability of data and insights
needed to manage conduct and culture
Bank boards should re-evaluate their governance structure to
ensure a specific board committee has oversight of the
bank’s conduct and culture
1
5Banks should explore ways to
celebrate role models in behavior – both in business decisions and
in individual actions
6Bank governance structures
must recognize the integral role that middle management plays in embedding cultural reforms and promoting values through lower levels of the organization
7Banks should make efforts to
promote diversity and inclusion in the workplace in their hiring
and staff development practices
8Banks should promote an
environment of “psychological safety” that encourages
employees to speak up and escalate issues or share feedback without fear of retribution; bullying or
aggressive management must not be tolerated
Source: G30 Report – Banking Conduct and Culture: A Permanent Mindset Change
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Australian Banking Conduct CrisisCase study
Establishing the right culture and staff conduct has been a pressing issue for Australian financial institutions. The Australian financial industry was tainted by a series of misconduct scandals following the 2008 global financial crisis. Banks were especially blamed for recurring conduct failures, which have led to over AU$1 billion in penalties and compensation since 2008, as well as the removal of senior executives and numerous legal and criminal investigations.
In the wake of rising public distrust towards financial institutions, the Australian Prudential Regulation Authority (APRA) and Oliver Wyman in 2018 conducted a prudential inquiry into an Australian bank and they then released a report on its governance, culture, and accountability. Oliver Wyman used its financial services expertise to provide input and advice on international best practices and lessons learned. We also contributed to the assessment and shaping of recommendations.
The report outlined key weaknesses in various areas and recommendations for remediation. While the findings were specific to the bank in question, the report contains lessons for the banking industry as a whole.
Banks in Australia are now on the long journey to repairing their conduct and culture. It took more than 12 months of thorough inquiry to highlight shortcomings across the Australian banking industry. It will take more time to regain public trust: Trust takes years to build but can be broken in seconds.
The key issues identified in the report included the following:
– A lack of alignment between practices and frameworks for banking remuneration and indicators of good conduct
– A lack of senior leadership and board oversight concerning issues of conduct and culture
– Inadequate oversight and challenge by the board and its gatekeeper committees regarding emerging nonfinancial risks
– Unclear accountability, starting with a lack of ownership of key risks at the executive committee level
– The paucity or nonexistence of adequate internal controls
Recommendations for addressing the issues at the bank focused on the following points:
– More-rigorous governance of non-financial risks at the level of board and executive committee
– Exacting accountability standards reinforced by remuneration practices
– A substantial upgrade of the authority and capability of the operational-risk-management and compliance functions
– Injection into the bank’s DNA the ‟should we?” question in relation to all dealings with and decisions on customers
– Cultural change that moves the dial from reactive and complacent to empowered, so that the bank challenges for and strive towards best practice in risk identification and remediation
THE STAKES FOR KOREAN WEALTH MANAGERS
CONCLUSION
Korean wealth managers have, so far, tackled the mis-selling scandal by strengthening their compliance practices. However, this will not be enough to stop future mis-selling incidents and the consequent loss of trust and reputational damage.
We think that banks and securities firms should instead address the core issue and align its interests with those of its clients. To do this, they should set out to raise their capabilities and transform their culture according to the following principles: Be client centric; fully understand product and portfolio risks; and invest in the right capabilities and behavior.
Building the capabilities needed to implement these principles is not a short-term undertaking though. We think it could take between 6 months and a year. Wealth managers embarking on this journey might suffer financially in the short term, as they make the necessary investments in tools and talent. In the long run, however, successful implementation of this approach will win back clients’ trust – both by reducing the likelihood of future misconduct and centering their services on clients. That, in turn, has the potential to attract clients and convince them to ask the wealth managers to manage greater portions of their assets, putting them on a path to sustainable growth.
Oliver Wyman – A Marsh & McLennan Company www.oliverwyman.com
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